~ Investment Strategy

Morning Note: China’s future,

Martin Wolf has a piece in the FT in which he suggests various ways in which China might avoid the middle-income trap (http://on.ft.com/GQx8T2). Few countries have managed to make the transition from middle-income to high-income, and the reason is that they struggle to move from a growth model based on rising inputs of labour and capital to one driven by “improving skills and technology”, as Mr. Wolf puts it. I am less interested in how China might avoid the middle-income trap than in working out what is most likely to happen. China suffers from deteriorating demography, a corrupt and oppressive political system, weak property rights, a stifling Confucian culture that values conformity over innovation, and so on. I suspect it will fail to make the changes need to achieve the transition and therefore that its rate of growth will slow in the coming decades.

Bullard Suggests Policy Turning Point

James Bullard of the St. Louis Fed has said that monetary policy may be at a turning point. The US economy is improving, and he fears the potential for over-easing and expects that rate increases will come in late 2013. The market has treated this as news, but I do not think that it is. Bullard seems constitutionally inclined towards hawkishness; it seems to me that he has never grasped the nature or seriousness of the current situation. Other FOMC members do, and it is their voices that are likely to be decisive. Further, while the FOMC has stated that it expects rates to remain low until at least late-2014, it is not news that some participants expect rate increases sooner than that — the Fed has just started releasing charts of individual participants’ expectations that show exactly that.

Why the Slow Recovery?

In a new paper for the Brookings Institution (http://bit.ly/GQCBJH), two economists have attempted to disentangle the causes of the recent recession and to understand why the recovery has been slow. They place a lot of the blame on demographic factors. I am not sure about this — I would put a lot of the blame on government inaction — but the two ideas are not necessarily incompatible if government action is taken as given. I have yet to read any analysis of the paper but thought it was worth flagging up. The factors that the authors argue explain the characteristics of a variety of recessions are: oil shock, monetary policy shock, productivity shock, credit spread shock, uncertainty shock and fiscal policy shock; a concurrence of all of these kinds of shocks, they argue, was responsible for the severity of the recent recession.